Farley Thomas

The recent attention that exchange-traded funds have had from everyone from the FSA, the Serious Fraud Office and even the IMF does not concern HSBC global head of ETFs and wealth solutions Farley Thomas.

He says: “All this scrutiny is fantastic. Providers that have a good story to tell can put their best foot forward.”

Thomas says HSBC’s strategy is to focus on a small number of core ETFs that are simple, transparent and, above all, use physical rather than synthetic replication.

He joined the asset management industry from university. “The City seemed to be a good place not just to use your head but also to get rewarded for it.”

His first job was with Framlington, which he joined as part of its graduate training scheme. “I was accepted on the sales and marketing scheme, which was not very fashionable in those days. Everybody wants to be a fund manager and pick stocks and manage portfolios but I like to think I was more honest about what I might be good at.”

Thomas quickly gained experience in the different aspects of fund management. “In three years I did not become an expert but I had a great opportunity to mix with fund managers, management, operations people, go out on client visits and design products.”

This experience led him to HSBC, where he has since worked, with the exception of a stint in consultancy. He has held various roles in marketing and distribution at the company and in 2008 became involved in the development of its ETF business.

He concedes HSBC has not been a trail-blazer in the sector but says the firm’s decision to enter the market was not driven by a me-too attempt to grab a part of the growing market.

“Back then there was already almost $1trn in ETFs and a couple of hundred billion in Europe but we did not get excited about ETFs because of this. That is a backward looking view. We were thinking about what the composition of assets under management would look like over the next decade.”

Thomas says customer demands and analysis that the retail investment market is undergoing a long-term shift away from active management to low-cost, passive management prompted the launch of an ETF business.

“That led us to conclude there will be phenomenal growth in ETFs and index funds because they meet a demand that was already in evidence but we thought would grow significantly and so far we have been proved right.”

The success of ETFs in the US, where retail assets exceeded $1trn in 2010, with predictions this will double by 2015, show the size of the prize available to managers who get their strategy right.

In Europe, AUM figures are more modest but Thomas fully expects the market to follow the US example.

“Today, ETFs represent less than 5 per cent of mutual fund assets under management, so it is still a peripheral contributor to mutual fund AUM. If you focus on equity funds, this suddenly jumps. If you just look at equities, ETFs represent closer to 10 per cent of assets under management, so suddenly it makes you think one in 10 dollars invested in equity funds in Europe is in an ETF. This is encouraging in that it was starting from zero not too long ago.”

He believes that over the long-term, the percentage of equity assets in ETFs could get as high as 40 or 50 per cent.

But Thomas says HSBC’s strategy is at odds with much of the asset management industry. “There are too many funds,” he says, comparing about 35,000 mutual funds available in Europe with the 8,000 available in the US.

“The US market is the biggest in the world and seems happy with about 8,000. Adjusting for a larger European population, we probably need around 10,000 funds - a third of the number.”

With this in mind, HSBC chose to keep the number of ETFs available low. It has 25 funds in its portfolio and says this will grow to no more than 30. “The market leaders have around 100 ETFs, so I said we might get to 30, about one-third.”

In addition to the current 25, Thomas says HSBC is considering a global emerging markets ETF and an ETF Civets fund to complement the unit trust.

Thomas says his key focus is making sure the products are understandable and therefore avoiding synthetic replication. “We set out our stall right from the start with a strong emphasis on keeping it as simple and as intuitive as possible and respecting our customers preferences. So we focused on the physical product as we have no intention to do otherwise.”

Thomas does not condemn the use of synthetic replication by other ETF providers but agrees regulators are right to have a closer look at their use.

He says the industry needs to get much better at disclosing all the necessary investor information. “There is a lot more that can be done so that caveat emptor is fairer. Buyer beware is fair enough if the buyer is given all the information to understand what they are doing.”

Thomas is confident HSBC’s approach is a winning one. “If we can maintain a focus on building simple, physical products that are transparent and good value, we should aim to be among the top 10 in Europe. We could do a lot better than that but we should definitely be in the top 10.

“But we are not going to do it by launching ever more ETFs, we are going to try and buck the trend. Inevitably, we will launch more but they will be targeted, high-conviction products.”

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